FCX Stock Analysis: Faltering Copper Demand Along With Poor Fundamentals Creates A Short Sell Oppurtunity

This article was written by David Shabotinsky, a Financial Analyst at I Know First, and enrolled at an undergraduate Finance program at the Interdisciplinary Center, Herzliya.

FCX Stock Analysis

Summary:

  • Background of Freeport McMoran’s (FCX) divestment from Oil & Gas (Energy Sector) and outlook for future
  • Systematic outlook on copper & commodities for the near-term and big market players
  • Fundamental value analysis on FCX using prominent indicators from Benjamin Graham
  • Bearish outlook on both copper and FCX as a result of a strong correlation
  • I Know First maintains a bearish outlook on both copper prices and Freeport McMoran

Background

Freeport-McMoRan Inc. is an international natural resources company. The Company operates large, long-lived, geographically diverse assets with significant reserves of copper, gold, molybdenum, cobalt, oil, and gas. It holds interests in various mines located in the Grasberg minerals district in Indonesia; Morenci, Bagdad, Safford, Sierrita, Miami, Chino, Tyrone, Henderson, and Climax in North America; Cerro Verde and El Abra in South America; and the Tenke Fungurume minerals district in the Democratic Republic of Congo, Africa.

FCX Stock Analysis

FCX has been consolidating and selling off its ‘non-core’ assets to work towards becoming a ‘pure copper play’. Those an initial thought may be that this is great considering that oil prices have dramatic dropped over the past couple years and have badly damaged FCX, it now correlates even more with the copper market in a forward-looking manner.

Fundamental Value Analysis

In general, those looking to invest based off of a more fundamental approach, whereas the investor believes in an intrinsic value or the ‘Firm-Foundation Theory’, are concerned with either two approaches. Either one chooses a ‘value stock’, where the underlying security is being underpriced and/or one chooses a growth stock whereas even if the price accurately reflects the market situation it has room to continue to grow. Using an analysis from Benjamin Graham, the father of value investing, one can further examine the fundamental situation of FCX. The company has been working to reduce is their long-term debt position, yet it continues to outweigh their current assets, which is an important criterion for Graham. Their long-term debt currently stands at $18.549 billion, while their net current assets are at $6.16 billion A Low P/E ratio is a popular condition for finding low valued firms, and Freeport McMoran does not have a ‘real’ one as they continue to have negative earnings. Additionally, Graham explains that companies should increase their EPS by at least 30% over a ten-year period, and have no negative EPS for a 5-year period. FCX has had negative EPS within the last five years.

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(Source: http://www.relakhs.com/)

Market Commodity Outlook on Copper & Effect on FCX

Currently, the share price is too expensive as the price already reflects the firm’s position in selling assets to reduces its exposure in the oil & gas (energy) sector. It has already had a great run for 2016, whereas allowed many investors to achieve returns that tripled initial investments. However, as of late, it’s been a downward trend indicating investors are over the uptick. They have sold assets to help reduce their massive debt load, but management needs to do more to actually help grow the firm in a positive direction. Investors should expect a price to continue to rise on accounts of past asset sales.

Though it seems management is intending to become more a copper play, the firm is as well selling off core assets relating to their copper operations to again earn cash for their debt payments.

Back in August, 2016, Goldman Sachs already began speaking about a bearish outlook on prices in Copper. They anticipate the copper prices are continuing to decline to about $4000. Though many commodities such as zinc and coal have had growth in prices, as a result of supply shortages, copper supplies have actually been increasing throughout 2016, and are expected to continue.

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Back in June 2016 even a representative FCX who heads Freeport-McMoRan Sales, Stephen Higgens explains that the higher production relative to a slowing demand in China has hurt copper prices. Furthermore, Goldman expects a global supply boost through 2017, specifically from the Grasberg mine in Indonesia, Escondido in Chile and Sentinel in Zambia, according to the report.

Today, copper continues to fall with many commodities analyst expecting that copper will continue to fall due to lack of demand, specifically from China; and will likely head in a similar direction to that of coal. Whereas it will dip lower and rebound afterward to eventually hit equilibrium.

Since supply will unlikely be reduced in the near future, investors need to turn to demand. China released reports for September, 2016, showing that they had imported 25% less copper volume, relative to the previous year. Goldman Sachs continues to believe that an oversupply of copper will continue to damper prices in the near term. “Over the next three to six months we believe that copper will continue to underperform zinc, with copper about to hit a wall of supply, while the zinc concentrate market continues to tighten,” Jeffrey Currie of Goldman Sachs and his team of analysts said in a note.

Furthermore, Bank of America as has recently taken more of a bearish outlook on FCX, they have recently downgraded the firm, with a price target of $8.00. Similar reasons were explained for why a downgrade was issued, relating mainly to a negative macro outlook on copper. The price target from Bank of America was found through a combination of the FCX’s net present value (NPV) for 2016 being 1.2 times Enterprise value (equity value plus debt value of a firm) divided by EBITDA, and 5 times larger than a 2017 version.

In addition to Wall Street banks having a bearish outlook for FCX and copper, I Know First’s state of the art AI-based algorithm as well maintains a bearish outlook on copper prices in the near future.

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How FCX Share Price Currently Stands 

Though its other operations in commodities, such as gold can help boost its earnings in the next few quarters, it is seeking to divest away from its core copper divisions and a rise in gold prices may not be enough to offset copper losses. Furthermore, a drastic poor use of cash by management is to continue dividend payments, which are at $0.21 for the past twelve-months (2% yield), even though the firm has below industry average growth and is not profitable. Though they have drastically been reducing costs and have increased earnings to -$338 million in Q2 2016 from -$4.184 billion in Q1 2016, their current price does, in fact, reflect this situation. One can see this if they examine the share price of the firm, which has been falling over the six-months, with a sharper decline over the past few months. Freeport’s share price has fallen almost 20% over the past three-months.

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Conclusion

Though management has made efforts to reduce FCX’s exposure to the harsh decline in O&G and reduce its debt, the market has already rewarded Freeport McMoran as shares have risen exponentially over the past year. Currently, the systematic risk is high for FCX as a poor copper outlook is seen from prominent investment banks and I Know First’s state of the art algorithm. If copper prices move in similar fashion to that of coal, then over time FCX can once again be a great buy opportunity. Currently, due to poor value fundamental indicators and systematic risks, the firm can be a great short sell opportunity, while these weaknesses remain.

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